Risks of Contagion in Asia - Research Proposal Example

Name: Professor: Course: Date of submission: Contagion: Contagion is the spread of market crises like financial crises from one country to the other, by co-movements in trade rates, stock prices, sovereign spreads, and capital flows (Unsal & Caceres 2011). Correspondingly, Contagion can also mean the advancement of cross-market treads from a shock of a certain nation which is difficult to understand it neither through theoretical model nor empirical works. In other words Contagion is a financial problem transmitted from one institution to another for instance a bank running spreads from little banks to several others, or with intra-countries (Unsal & Caceres 2011). In general, Contagion is a situation that occurs after a financial institution’s failure and it threatens constancy of several other institutions worldwide. Fiscal linkage is as a result of financial globalization because a nation struggles to be economically stable and integrated with international economic markets. Allen and Gale (2000), together with Lagunoff and Schreft (2001) examined economic contagion in accordance to linkages of financial intermediaries. They explained how small liquidity first choice shock in one locality spreads all over economy and probability of contagion to occur rely on comprehensiveness of the structural interregional claims. International financial contagion occurs in both sophisticated economies and growing economies, is the diffusion of financial predicament athwart financial markets for straight or circumlocutory economies. Causes and Consequences: Financial contagion causes and financial which destroy both economy and the financial strategies of the countries. The financial contagion is caused by the four financial agents like Government, Financial Institutions, Borrowers and Inventors (Unsal & Caceres 2011). These agents are spread out effects and financial catastrophe that they cause and financial influence. A primary factor that causes contagion is macro-economic shocks both globally and locally transmitted via trade relations, aggressive devaluations, and fiscal relations. These macro-economic shocks enhance co-movements flow in capital and assets prices (Arnaboldi 2014). The extreme of these shocks bring financial crises and effects such as decrease of; trade credits, overseas direct savings and capital flows in the world. Trades links are shocks focuses on their incorporation thus causing local impacts such as reductions in exports and thus worsen the trades’ accounts. The affected country experience strict current collapse, depreciation of asset prices and huge currency outflows.  Kaminsky and Reinhart (2000) document provide an evidence of goodness of the trade links services and exposure to creditors. These evidences show and give an explanation about the former and the current trade crises such as the debt crisis of 1980s and 1990s, and historical prototype of contagion. Competitive devaluation or currency war causes financial contagion. Competitive devaluation is a situation where multiple countries contend in order to win a competitive advantage by giving low exchange rates for their currency. Devaluation reduces the sell overseas competitiveness of the regions which they compete with in third markets, pressuring other countries currencies if the currencies don’t flow freely and eventually causing those countries to have fear and doubt (Arnaboldi 2014). Out of fear and doubt, the market participants sell off their security holdings, curtail the lending and deny short period loans to borrowers of the affected countries. Increased risk repugnance, low confidence, and financial reservations can also cause contagion. Under the allied information control, market price fluctuations perception provide an implication of disvalue and price change of assets prices on other places (King and Wadhwani (1990). When some of the markets participants require to liquidate and pull out particular assets in order to get cash especially when a loss is experienced in another country and a need of capital adequacy rations restoration grows, then eventually the shock will be effectively transmitted (Calvo 1999). There are some geographic factors that facilitate contagion. De Gregorio and Valdes (2001) evaluated the extent of 1982 debt crisis, the 1994 Mexican crisis, and the 1997 Asian crisis extended into other 20 countries. They found out that the environment effect is a strong determinant of the countries that can suffer contagion. Excessive borrowing by national banks causes the contagion state. National banks incessantly rented from abroad countries lent in their country. At the beginning of the crisis, public equity betas appreciate and standard income fell considerably (Unsal & Caceres 2011).  The investors begin re-evaluating their savings in this expanse therefore causing the money in-flow to disappear quickly, ensuing in the expansion of this catastrophe. Influence of borrowing finance investments is one of the contributors of financial crises. When an institution invests its own money, experiences its own loss but when it borrows to expand their invest, so incase of lose they lose a lot. Therefore, leverage expands the prospective returns from speculation, but also susceptible to a risk of bankruptcy thus cause the spread of financial troubles in many firms. The Extent of Contagion Risk: The World’s worst crisis is the stock market crash. The failure was as a result of the collapse of the commodity prices in many of the third world countries. The stock market by 1928 torn off the US capital inflow and outflow to central Europe and Latin America which later precipitated monetary values in many countries. The Wall Street crash has created a stock market phobia worldwide which resulted to Great Depression. This U.S. crisis of 1929 caused the Great Depression in 1930-1931fiscal year since Federal Reserve failed thus causing panic in many of the world banks. As a result, the prices collapsed and forced the world borrowers to stop servicing debts. The world contagion contributed to the 2007-2008 crises which was the most worst from that of 1930 Great Depression. The most prominent financial institutions in the world were severely affected as a result of high default rates. In 2008, U.S investment bank such as Bear Sterns put more efforts to rectify the problem but it became more intense. The crises became deeper and spread its effects to other financial institutions like Lehman bank and American International Group (AIG). This problem caused a big fiscal problem all over the world specifically countries that depend on international borrowing. Financial contagion became more severe, mostly in countries whose monetary systems are susceptible because of the account deficits. Some of these countries include Iceland, Britain and Germany. The effect was very severe that almost every economy was affected either directly or indirectly by the crisis and consequently caused the decline of exports and decreasing the community prices (Batten & Szilagyi2011). Financial contagion turmoil in the United States financial markets was as a result of financial contagion. A large cash outflow than the inflow from large banks is experienced within the cross-regional operation of these banks. The effect of these of financial contagion was beyond the clarification of authentic economy. Methods of managing Contagion both on an Individual (institutional level) and International levels. Domestic financial regulation and international financial architecture are methods of solving and preventing the problem caused by the financial contagion. This is the most promising method of prevention of the contagion on both domestic and international societies. The method is convenient when the world economy is under pressure of challenges especially US Subprime mortgage catastrophe and European autonomous debt emergency. Internationally, financial systems, comprises of a dense convoluted mesh of claims and responsibility that connects the balance sheets of various intermediaries, like hedge funds and banks, into an international pecuniary network (Batten & Szilagyi2011). So to solve the calamity of development of classy financial goods, credit evasion and collateralized debt duty which complicate the financial control should be addressed appropriately. With the control of the above financial challenges, the world is now safe and less vulnerable to the affection of financial contagion. For instance, the US financial depression triggered the downfall of Lehman Brothers where the shock further spread to the other financial organization and markets. The remedy for the problem like this is therefore to understand the causes and mechanisms of global financial contagion. This enable the policy makers perk up the world’s fiscal regulation system hence making more strategies to resist the shocks and contagions experienced. At domestic echelon, economical fragility is mostly linked with a diminutive maturity of dazzling debt and contingent open liabilities. So a superior domestic financial rule pattern can advance an economy’s liquidity thus reducing its susceptibility to contagion (Batten & Szilagyi2011). Again a better know-how of financial contagion within the financial mediators like hedge funds, banking and rating will help in improving the financial reform formulation in all the affected countries such as US and European Nations (Arnaboldi 2014). The financial mediators will help in creating a capital ratio to harmonize the balances between optimizing the profit gotten by the banks and defending it from shocks and contagions. References Agénor. (2006). The Asian financial crisis. Cambridge: Cambridge University Press. Arnaboldi, F. (2014). Deposit guarantees schemes: a European perspective. Basingstoke: Palgrave Macmillan. Bisignano, J., Hunter, W. & Kaufman, G. (2000). Global Financial Crises Lessons from Recent Events. Boston, MA: Springer US. Morris, N. & Vines, D. (2014). Capital failure: rebuilding trust in financial services. Oxford: Oxford University Press. Stallings, B. & Studart, R. (2006). Finance for development Latin America in comparative perspective. Washington, D.C: Brookings Institution Press. Dilip K. Das (2004). Financial Globalization and the Emerging Market Economy. Boston, MA: Springer US. Batten, J. & Szilagyi, P. (2011). The impact of the global financial crisis on emerging financial markets. Bingley, U.K: Emerald. Machina, M. & Viscusi, W. (2014). Handbook of the economics of risk and uncertainty. Oxford: North-Holland. Unsal, D. & Caceres, C. (2011). Sovereign Spreads and Contagion Risks in Asia. Washington, D.C: International Monetary Fund .Velde, D., Massa, I. & Calì, M. (2010). Supporting investment and private sector development in times of crisis: strategies for small states. London: Commonwealth Secretarial. Batten, J. & Szilagyi, P. (2011). The impact of the global financial crisis on emerging financial markets. Bingley, U.K: Emerald. Read More